The Revenue Cycle: Sales and Cash Collections Chapter 10

Learning Objectives Describe the basic business activities and related data processing operations performed in the revenue cycle. Discuss the key decisions that need to be made in the revenue cycle and identify the information needed to make those decisions. Document your understanding of the revenue cycle. Identify major threats in the revenue cycle and evaluate the adequacy of various control procedures for dealing with those threats.

Revenue Cycle Business Activities The revenue cycle is a recurring set of business activities and related information processing operations associated with providing goods and services to customers and collecting cash in payment for those sales.

Revenue Cycle Business Activities What are the four basic revenue cycle business activities? Sales order entry Filling customer orders and Shipping Billing and accounts receivable Cash collections

Revenue Cycle Business Activities: Sales Order Entry Sales order entry process entails three steps: Taking the customer’s order Checking and approving the customer’s credit Checking inventory availability

Tue 29-3 Revenue Cycle Business Activities: Shipping The second basic activity in the revenue cycle – filling customer orders and shipping the desired merchandise – entails two steps: Picking and packing the order Shipping the order

Revenue Cycle Business Activities: Billing and Accounts Receivable The third basic activity in the revenue cycle involves: Billing customers Updating accounts receivable

Revenue Cycle Business Activities: Cash Collections The fourth step in the revenue cycle is cash collections. It involves: Handling customer remittances Depositing remittances in the bank

Revenue Cycle – Key Decisions The revenue cycle’s primary objective is to provide the right product in the right place at he right time for the right price. How does a company accomplish this objective? To accomplish the revenue cycle’s primary objective, management must make the following key decisions:

Revenue Cycle– Key Decisions To what extent can and should products be customized to individual customers’ needs and desires? How much inventory should be carried, and where should that inventory be located? How should merchandise be delivered to customers? Should the company perform the shipping function itself or outsource it to a third party that specializes in logistics?

Revenue Cycle – Key Decisions Key decisions, continued Should credit be extended to customers? How much credit should be given to individual customers? What credit terms should be offered? How can customer payments be processed to maximize cash flow?

Thu 31-3 Sales Order Entry (Activity 1) This step includes all the activities involved in soliciting and processing customer orders. Key decisions and information needs: decisions concerning credit policies, including the approval of credit information about inventory availability and customer credit status from the inventory control and accounting functions, respectively

Sales Order Entry (Activity 1) The sales order entry function involves three main activities: Responding to customer inquiries Checking and approving customer credit Checking inventory available

DFD for Sales Order Entry 1.1 Take Order Customer Orders Customer Rejected Orders Orders 1.2 Approve Credit Inquiries Response DFD for Sales Order Entry Acknowledgment Customer Approved Orders 1.3 Check Inv. Avail. 1.4 Resp. to Cust. Inq. Sales Order Inventory Back Orders Sales Order Sales Order Picking List Shipping Billing Ware- house Purchas- ing

Mon 28-3 Information Needs and Procedures The AIS should provide the operational information needed to perform the following functions: Respond to customer inquires about account balances and order status. Decide whether to extend credit to a customer.

Sales Order Entry (Activity 1) Regardless of how customer orders are initially received, the following edit checks are necessary: Validity checks A Completeness test Automatic lookup of reference data like customer address. Reasonableness tests comparing quantity ordered to past history. Credit approval General authorization Credit limit (for existing customers) Specific authorization Limit checks (new, have past-due balances, Exceeding)

Mon 8-11 Sales Order Entry (Activity 1) Next, the system checks whether the inventory is sufficient to fill accepted orders. Internally generated documents produced by sales order entry: sales order packing slip picking ticket

Information Needs and Procedures Determine inventory availability. Decide what types of credit terms to offer. Set prices for products and services. Set policies regarding sales returns and warranties. Select methods for delivering merchandise.

Thu 1-4 Shipping (Activity 2) Warehouse workers are responsible for filling customer orders by removing items from inventory. Key decisions and information needs: Determine the delivery method. in-house outsource

Shipping 2.1 Pick & Pack Sales Order 2.2 Ship Goods Inventory Entry Picking List Goods & Packing List Sales Order Sales Order 2.2 Ship Goods Inventory Bill of Lading & Packing Slip Billing & Accts. Rec. Goods, Packing Slip, & Bill of Lading Shipments Carrier

Shipping (Activity 2) Documents, records, and procedures: The picking ticket printed by the sales order entry triggers the shipping process and is used to identify which products to remove from inventory and the quantities. The packing slip lists the quantity and description of each item in the shipment. A physical count is compared with the quantities on the picking ticket (Warehouse) and packing slip (Shipping). If there are discrepancies, a back order is initiated. Some spot checks are made and a bill of lading is prepared.

Shipping (Activity 2) The bill of lading is a legal contract that defines responsibility for goods in transit 3 copies: (shipping, billing, and carrier) It identifies: The carrier The source The destination Special shipping instructions Who pays for the shipping?

Wed 10-11 Billing and Accounts Receivable (Activity 3) Two activities are performed at this stage of the revenue cycle: Invoicing customers Maintaining customer accounts Key decisions and information needs: Accurate billing is crucial and requires information identifying the items and quantities shipped, prices, and special sales terms.

Billing and Accounts Receivable Packing Slip & Bill of Lading 3.1 Billing Shipping Sales Order Entry Sales Order Invoice Sales General Ledger & Rept. Sys. Customer Customer Sales Monthly Statements 3.2 Maintain Accts. Rec. Mailroom Billing and Accounts Receivable Remittance List

Billing and Accounts Receivable (Activity 3) The documents in this activity: The sales invoice notifies customers of the amount to be paid and where to send payment. A monthly statement summarizes transactions that occurred and informs customers of their current account balance. A credit memo authorizes the billing department to credit a customer’s account. credit manager may issue a credit memo for: Returns Allowances for damaged goods Write-offs as uncollectible (after reprated attempts to collect money from a customer --- fail to collect)

Sun 3-4 Billing and Accounts Receivable (Activity 3) Types of billing systems: In a postbilling system, invoices are prepared after confirmation that the items were shipped. In a prebilling system, invoices are prepared (but not sent) as soon as the order is approved. The inventory, accounts receivable, and general ledger files are updated at this time.

Billing and Accounts Receivable (Activity 3) Methods for maintaining accounts receivable: open invoice method balance-forward method To obtain a more uniform flow of cash receipts, many companies use a process called cycle billing.

Billing and Accounts Receivable (Activity 3) Open-invoice method: Customers pay according to each invoice. Two copies of the invoice are typically sent to the customer. Customer is asked to return one copy with payment. This copy is a turnaround document called a remittance advice. Advantages of open-invoice method: Conducive to offering early-payment discounts Results in more uniform flow of cash collections Disadvantages of open-invoice method: More complex to maintain

Billing and Accounts Receivable (Activity 3) Balance forward method: Customers pay according to amount on their monthly statement, rather than by invoice. Monthly statement lists transactions since the last statement and lists the current balance. Advantages of balance-forward method: It’s more efficient and reduces costs because you don’t bill for each individual sale. It’s more convenient for the customer to make one monthly remittance.

Billing and Accounts Receivable (Activity 3) Cycle billing is commonly used with the balance-forward method. Monthly statements are prepared for subsets of customers at different times. EXAMPLE: Bill customers according to the following schedule: 1st week of month—Last names beginning with A-F 2nd week of month—Last names beginning with G-M 3rd week of month—Last names beginning with N-S 4th week of month—Last names beginning with T-Z Advantages of cycle billing: Produces more even cash flow. Produces more even workload. Doesn’t tie up computer for several days to print statements.

Tue 5-4 Information Needs and Procedures What are examples of additional information the AIS should provide? (performance Evaluation.) Respond time to customer inquiries Time required to fill and deliver orders Percentage of sales that required back orders Customer satisfaction rates and trends Profitability analyses by product, customer, and sales region Sales volume in both dollars and number of customers Effectiveness of advertising and promotions Sales staff performance Bad debt expenses and credit policies

Cash Collections (Activity 4) Two areas are involved in this activity: The cashier, who reports to the treasurer, handles customer remittances and deposits them in the bank The accounts receivable function

Cash Collections (Activity 4) Key decisions and information needs: Reduction of cash theft is essential. The billing/accounts receivable function should not have physical access to cash or checks. The accounts receivable function must be able to identify the source of any remittances and the applicable invoices that should be credited.

Cash Collections (Activity 4) Documents, records, and procedures: Checks are received and deposited. A remittance list is prepared and entered on-line showing the customer, invoice number, and the amount of each payment. The system performs a number of on-line edit checks to verify the accuracy of data entry.

Mon 22-11 Control: Objectives, Threats, and Procedures In the revenue cycle (or any cycle), The second function of a well-designed AIS is to provide adequate controls to ensure that the following objectives are met: Transactions are properly authorized. (emp_ write off account) Recorded transactions are valid. Showing false revenues in a financial statement

Control: Objectives, Threats, and Procedures Objectives, continued Valid, authorized transactions are recorded. Don’t show Discounts higher net sales Transactions are recorded accurately. Assets (cash, inventory, and data) are safeguarded from loss or theft. Business activities are performed efficiently and effectively.

Threats and Applicable Control Procedures to Sales Order Entry 1. Incomplete or inaccurate customer orders Data entry edit checks 2. Credit sales to customers with poor credit Credit approval by credit manager, not by sales function; accurate records of customer account balances 3. Legitimacy of orders Signatures on paper documents; digital signatures and digital certificates for e-business 4. Stockouts, carrying costs and markdowns Stockouts Situation where the demand or requirement for an item cannot be fulfilled from the current (on hand) inventory. Carrying Cost: warehousing costs such as rent, utilities and salaries Inventory control systems

Threats and Applicable Control Procedures to Shipping 1. Shipping errors: Wrong merchandise Wrong quantities Wrong address Reconciliation of sales order with picking ticket and packing slip; bar code scanners; data entry application controls 2. Theft of inventory Restrict physical access to inventory; Documentation of all internal transfers of inventory; periodic physical counts of inventory and reconciliation of counts of recorded amounts

Applicable Control Procedures Thu 7-4 Threats and Applicable Control Procedures to Billing and Accounts Receivable Threat Applicable Control Procedures 1. Failure to bill customers Separation of shipping and billing functions; Prenumbering of all shipping documents and periodic reconciliation to invoices; reconciliation of picking tickets and bills of lading with sales orders 2. Billing errors Data entry edit control Price lists 3. Posting errors in updating accounts receivable Reconciliation of subsidiary accounts receivable ledger with general ledger; monthly statements to customers

Threat and Applicable Control Procedures to Cash Collections 1. Theft of Cash Segregation of duties; minimization of cash handling; lockbox arrangements; prompt endorsement and deposit of all receipts Periodic reconciliation of bank statement with records by someone not involved in cash receipts processing

Thu 25-10 General Control Issues Threat Applicable Control Procedures 1. Loss of Data Backup and disaster recovery procedures; access controls (physical and logical) 2. Poor performance Preparation and review of performance reports

Revenue Cycle Information Needs: Operational Data Operational Data are needed to monitor performance and to perform the following recurring tasks: Respond to customer inquiries about account balances and order status Decide whether to extend credit to a particular customer Determine inventory availability Select methods for delivering merchandise

Revenue Cycle Information Needs: Current and Historical Information Current and historical information is needed to enable management of make the following strategic decisions: Setting prices for products and services Establishing policies regarding sales returns and warranties Deciding what types of credit terms to offer Determining the need for short-term borrowing Planning new marketing campaigns

Revenue Cycle Information Needs: Performance Evaluation The AIS must also supply the information needed to evaluate performance of the following critical processes: Respond time to customer inquiries Time required to fill and deliver orders Percentage of sales that required back orders Customer satisfaction rates and trends Profitability analyses by product, customer, and sales region Sales volume in both dollars and number of customers Effectiveness of advertising and promotions Sales staff performance Bad debt expenses and credit policies